Stronger rupee, slower growth likely to hit IT firms' performance in 2019

The bigger worry is the concern around slowing growth in the US and Europe - the biggest markets of IT majors - accounting for more than 75 per cent of the revenue

IT was the best performing sector in 2018, with the Nifty IT index surging about 24 per cent during the year, outpacing the 3 per cent rise in the Nifty 50. With the exception of Wipro and HCL Technologies, the other three sector leaders Tata Consultancy Services (TCS), Infosys and Tech Mahindra gained 27-43 per cent returns last year.

What had helped the sector last year was a supporting environment in the US, be it tax cuts or fiscal spending, coupled with a weak rupee. “The IT sector’s strong performance in 2018 was predicated on robust earnings growth aided by currency tailwinds. The mid- and small-cap mayhem, uncertainty and liquidity crisis after IL&FS’ bankruptcy, and global concerns on materials sectors, have all essentially led to the IT sector’s splendid outperformance,” says Lakshminarayana Ganti, co-head of research at SBICAP Securities. Further investments in their digital portfolios and higher revenue growth from this line of business also helped boost overall growth rates.  

However, there are some headwinds that could lead to lower returns in 2019. While a strengthening rupee is good for the economy, it will, at the same time, translate into lower revenues for the export-oriented sectors such as IT. The rupee has recovered 5.5 per cent against the dollar from its lows in October 2018.

The bigger worry, however, is the concern around slowing growth in the US and Europe — the biggest markets of IT majors — accounting for more than 75 per cent of the revenue.  

“Besides a recovery in the rupee, growth in US and Europe, which are key markets of IT outsourcing firms, is slowing. This will weigh on their overall performance,” says Sunil Jain, head of research at Nirmal Bang.

Growth concerns regarding the US economy can also be gauged from the US Federal Reserve’s chairman indicating the possibility of a pause in interest rate hikes in case the US economy were to weaken from here on. The other worry from the returns perspective is valuations.
 

TCS currently trades around 20 times its FY20 estimated earnings. HCL and Infosys are valued at 12-16 times their respective FY20 estimated earnings, and are the top picks among IT majors.